Wednesday, May 21, 2014

Hereâs Why Cott Corporation Is a Long-Term Buy

It wasn't a good quarter for Cott Corporation (COT) as the company had trouble with its volumes. Cott Corporation engages in the production and distribution of retailer brand beverages in North America and globally. It offers carbonated soft drinks, flavored waters, energy-related drinks, juice, juice-based products, bottled water and ready-to-drink teas. It primarily serves grocery, mass-merchandise, drugstore, wholesale and convenience store chains.

Time to Improve

Cott Corporation is of the strong view that its comparables will ease in the current fiscal 2014, and raw material tailwinds should kick in at current spot rates. This would stimulate the company to profitability. However, the key question remains, how long will it take for trends to stabilize?

As stated by Deutsche Bank analyst Bill Schmitz Jr. in a client note, "Today, the biggest risk to an otherwise compelling growth and margin opportunity in 2014 is aggressive competitive price points by the national branded competitors, who appear to be redeploying savings from likely unanticipated commodity cost weakness to relatively deep price promotions."

However, Cott Corporation is struggling under the effects of various aspects such as weak category trends, stubbornly high commodity costs, irrational competitive behavior, suboptimal weather, or one of the several other factors that have popped up to delay the company's progress in any quarter over the last year.

Cott Corporation was also hammered in the summer promotion on two-liter products that had persisted well in the previous quarter, where one branded competitor is still pricing its two-liter portfolio at sub-$1 per bottle. Both Coke and Pepsi had issued pricing letters in late September, but the retail pricing doesn't seem to be improving till now.

What Will Drive Growth?

Nevertheless, it is important to note that though there are various potential risks that loom and Cott Corporation has been very cautious on the overall carbonated soft drink landscape in fiscal 2014, it looks relatively convincing.

In addition, the company has experienced significant growth in the UK market that accelerated in the reported quarter, accompanied by Calypso and continued diversification away from its Carbonated Soft Drink (CSD) category. Cott has now been exposed to the European consumption environment. This, too, has delivered positive signs as sales have picked up of late.

Cott expects to recognize a relative significant margin tailwind in 2014, provided the commodity environment continues to co-operate. It also expects to increase its gross margin though hedge positions.

Moreover, Cott Corporation has been clear that the commodity upside from apple juice focus prices will be spent back in order to further drive category growth. Therefore, the company could benefit from this sound decision in the long run and improve its profitability eventually.

Calendar 2014 looks compelling despite recent category softness and elevated promotional activity in the U.S. There is potential upside in Cott shares, with likely cash flow increases. In addition, the company has enough potential as it focuses on additional capital structure optimization.

Conclusion

The category deflating promotional activity cannot continue forever, with Coke and Pepsi's recent pricing letters to lead to potential steps in the right direction. Free cash flow generation should continue to support Cott shares through this prolonged volume downturn.